Equity markets trended higher but wait-and-see environment dominates Europe

Asset Management - 25/11/2016

In a short week on US markets because of the Thanksgiving holiday and Black Friday, equities edged steadily higher on upbeat economic data both in the US and in Europe.

Durable goods orders for October jumped 4.8%, much higher than expected and Markit’s manufacturing PMI for November and the Michigan consumer confidence index both surprised on the upside. The eurozone followed suit with encouraging PMI data, particularly in services. As a result, the eurozone's composite index rose from 52.8 to 54.1 in November.

The durable goods data sent both the US dollar and Treasury yields higher, although the dollar made little progress against the euro over the week. Dollar strength was more marked against the Yen and that resulted in Tokyo bouncing more than other markets.

European markets are currently in thrall to political uncertainty. This has led to widening spreads between German Bund yields and other eurozone country debt. The shift has been more pronounced in France and Italy where political risk is highest. Investors are in wait-and-see mode ahead of the Italian referendum and the ECB’s meeting in the following week.

Against this backdrop, last week we turned more cautious on eurozone equities, a move that was primarily achieved through hedging. We have taken some profits on Japanese equities and the US dollar following the rebound seen in recent weeks. In our sovereign debt positions, we have raised modified duration to US bonds and now have neutral weightings 

  European equities

European markets trended higher on the back of rather reassuring company results. 64% of eurozone companies met consensus estimates on third quarter results.

In sector terms, consumer staples posted disappointing results but banks had a very good quarter and expectations for 2017 have been revised higher.

In the UK, sterling’s steep decline and higher commodity prices are underpinning growth forecasts for 2017.

In company news, there was confirmation that Essilor’s growth profile had weakened. The group posted only a moderate 3.2% in growth in the third quarter and lowered its guidance on annual growth from 4.5% to 3.5%, citing poor trading conditions in the US, Brazil and the Middle East. But it also announced two acquisitions in Asia which should partially offset weaker growth.

In the aerospace sector, Zodiac’s results were generally in line and the group still expects to return to historic profitability levels over the medium term. But guidance on 2017 results was sharply lower than expected mainly because of cost overruns in the deployment of its Focus transformation plan.

In wines and spirits, Remy Cointreau posted robust figures due to China's recovery in the up-market bracket and strong performance from Cointreau in the US. Management is highly confident it will meet consensus expectations that operating profits will rise by between +8%% and+9% over the year.

In other news, Vivendi continued to increase its stake in Telecom Italia and now has 17%.

After making acquisitions in Europe’s tourism sector, China’s Fosun has bought a 17% stake in the Portuguese bank BCP.

Monte Paschi's shareholders voted by 96.1% in favour of the bank's EUR 5bn recapitalization plan. This will focus on an increase of capital that the bank's CEO hopes to complete by Christmas.

Actelion (biotech) rose sharply after reportedly receiving an initial bid from Johnson &Johnson. 

  US equities

Indices edged higher in a short Thanksgiving holiday week.

October’s durable goods orders jumped 4.8% or much more than the 1.7% expected. Property market data on new and existing home sales were broadly in line with expectations.

In technology, Symantec (IT security solutions) is paying USD 2.3bn to acquire Lifelock which designs protection against identity theft for individuals and small companies and boasts 4.4 million users.

In apparel, Urban Outfitters plunged 10% after releasing lacklustre results on specific brand problems.

In pharma, Eli Lilly fell after announcing disappointing results in its phase 3 trial of a treatment against Alzheimer’s disease. Biogen, which is in phase 3 for a similar drug, also retreated on the news. Farm equipment giant John Deere jumped 10% on better-than-expected results due to strong order flow from Latin America.

Over the last 5 days, energy, telecoms and consumer discretionary led advances. Healthcare, property and utilities all ended the week lower. 

  Japanese equities

The Topix index ended the week 2.6% higher, extending its longest winning streak since June 2015. The Topix and Nikkei 225 rose for the 10th and 6th day in a row respectively on expectations of better exporters' earnings thanks to the depreciating yen.

The yen weakened 4% against US dollar and 2.3% against the euro.

This week's top sectors were Iron & Steel (+6.1%), Transportation Equipment (+5.3%) and Real Estate (+5.2%). Only the Pharmaceutical sector posted a negative return (-2.1%).

Murata Manufacturing, one of the biggest manufacturers of wireless modules for iPhones, jumped 10.4%. This was due to growing expectations of an upward revision in earnings due to yen weakness and follows a poor first half when the share retreated after Donald Trump called for a boycott on Apple’s products.

Eisai, a pharmaceutical company which has a mild dementia drug under development, tumbled 7.1% after its US peer, Eli Lilly, announced disappointing results in a clinical trial for the same disease. 

  Emerging markets

Emerging markets were hit hard after Donald Trump’s unexpected victory in the US elections, but they stabilised over the last week.

In China, officials announced that more than three quarters of the USD 46bn in planned Chinese-led investment in Pakistan will be implemented by next year as part of China’s plan to build a modern day Silk Road.

After the demonetization of the old 500 and 1,000 Rupee bills, the Indian government is facing huge organisational challenges. Not only will it take months to print enough 100s and 500s notes that will replace the old bills, but the Indian central is also facing logistical constraints distributing the money to the 130,000 bank branches and 200,000 ATMs across the country as it only has 8,000 vehicles at its disposal.

After targeting Google, Indonesia is now going after social network giant Facebook for unpaid taxes and penalties. The government's latest move comes after Google was expected to reach a tax settlement with Indonesia in the next few weeks.

In Korea, the offices of the Samsung group were raided for a third time in three weeks by prosecutors as a scandal engulfing the country’s president and her top advisers went deeper into the tech giant. 

  Commodities

The countdown has started to the much-awaited OPEC meeting on November 30.

Two years ago when members met on November 27 2014, they decided not to reduce output even though the market was in surplus due to rapidly increasing shale oil production and falling demand. Prices have since averaged USD 48 for Brent crude and USD 46 for WTI or half the levels seen in 2010-14.

This has damaged the finances of producer countries but the expected effects have largely come to pass: the market is now close to balance and US production has fallen by 1 million b/d since its March 2015 high. But OPEC’s production is now running at record levels (33.8 million b/d in October) due to Saudi Arabia, Iraq and Iran's return while Libya and Nigeria are trying to get back to previous production levels.

Since the Algiers meeting at the end of September, OPEC and some non-OPEC countries like Russia have scaled up meetings in an attempt to reach an agreement on cutting output. Given market expectations, the risk has become highly asymmetrical.

Failure to strike an agreement would drag prices back down towards USD 40 over the short term.

An agreement to limit output to 32.5/33 million b/d without any country breakdown would stabilize prices above USD 50.

A more radical and detailed agreement, with Russia’s participation, would be the most favorable scenario and could be expected to push prices above USD 55 over the short term.

But in light of OPEC’s long history of not completely holding to objectives, markets will probably wait to see hard evidence of production cuts in the coming months. As a result, over the medium term, prices will probably be capped at USD 60, the level at which US shale oil production now becomes profitable.

Gold has remained under pressure since the US election and is down by 7% or USD 100/oz. This is due to the US dollar strengthening to a 14-year high, higher bond yields and a close to 100% probability that the Fed will announce a rate hike when it next meets. 

  Corporate debt

Credit

It was a quiet week with no major trends on credit markets because of the Thanksgiving holiday in the US. But Italian corporate bond prices continued to fall in the run-up to the December 4 referendum. Elsewhere, very long-dated senior corporate debt fell following rises in credit risk premiums and core country interest rates. The Main and Xover indices ended the week almost flat at 81bp and 341bp respectively.

In news on our coverage, CMA CGM’s third quarter results remained very weak; Volkswagen unveiled a plan to bolster the VW brand’s profitability with plans to save EUR 3.7bn by 2020, of which 3bn in Germany alone.

Alain Afflelou told Reuters that he was putting back plans for an IPO until 2017 due to unfavorable market conditions.

Early in the week, the FSB (Financial Stability Board) released its new list of 30 globally systemic banks and indicated the extra amounts needed to respect Common Equity Tier1 capital requirements in 2017.

Italy’s Monte Paschi bank’s EUR 5bn recapitalization plan was approved by its shareholders. 

Convertibles 

It was a quiet week with holidays in Japan and the US. Nonetheless, the dollar continued its rally with the DXY index breaking the 100 level, sending Japanese equities up +2.9% on the week (the USD/JPY touched 113).

In the US, cyber security company Palo Alto disappointed investors with its Q1 2017 results as revenues marginally missed estimates owing to new deal delays. However, gross margin increased by an impressive +1.5% to 79.4%.

In Europe, Nyrstar jumped +8% this week on the back of stronger zinc prices driven by increased demand from industrial users.

Grand City Properties was upgraded one notch to BBB+ by S&P as vacancy rates fell well below 10%, supporting free cash flow.

SEB got EC approval for the acquisition of the professional coffee machines maker WMF.

Nasdaq-listed, Chinese internet company, Sina, rose +11.5% as the company announced stronger than expected results helped by its 50% stake in Weibo, which saw continued growth of active users. 

 

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